29 June 2023
In an ever-changing environment, the need for certainty during retirement has become more urgent and has resulted in a general shift to conventional life annuities as the product of choice. Understandably, retirees are looking for the highest level of guaranteed income that their savings can buy, with the added advantage of their income keeping up with inflation. Most importantly, retirees want to ensure that their monthly income needs are met without added risks. Linda Blom, business development manager at Glacier, answer some pertinent questions around the guaranteed term of a life annuity.
How will your income be determined?
Many factors determine the initial guaranteed income of a life annuity, such as:
- your age;
- your gender;
- your life expectancy;
- the mortality rate in your particular insurance risk pool;
- interest rates;
- your desired income for a single or joint life;
- your choice of growth in income (0% - 7% or CPI); and the
- guaranteed term that you choose (0, 5, 10, 15 or 20 years).
What does ‘guaranteed term’ mean?
A life annuity provides a guaranteed income until you die, irrespective of the age you reach. The term on a life annuity determines the minimum years of guaranteed payment if you pass away within the guaranteed term. This ensures that your beneficiaries will receive an income for the remainder of the guaranteed term that you chose when you made the investment – either 5, 10, 15 or 20 years. The higher the guaranteed term, the lower the initial income and vice versa.
If you choose not to have a guaranteed term, there will be no further income payments to your beneficiaries when you pass away. This option will provide the highest initial income, but higher doesn’t necessarily mean that it’s better!
Bob’s story
Bob retires at 65 and invests R1 million in a single life annuity with a 5% annual increase in income. His initial monthly income for the various available guaranteed terms is illustrated in the table below:
| Guarantee term | 0 | 5 | 10 | 15 | 20 |
| Initial gross income | R7 474 | R7 298 | R6 938 | R6 617 | R6 367 |
Note: Illustrative rates for the week 9 November 2020
As you can see, the initial income decreases as the guaranteed term increases. So, it may seem that the value of the shorter guaranteed term is the better option as the income is higher, but this would depend on your individual circumstances and needs.
Let’s say Bob decides on the 20-year guaranteed term and then passes away in the fifth year. His beneficiaries will receive a monthly income with an annual escalation of 5% per annum for the next 15 years. Essentially, the chosen guaranteed term of 20 years means that the insurer must pay an income for at least this period. A starting income of R6 367pm, escalating with 5% per annum over a period of 20 years, equals total of income payments by the insurer of R2 526 371. This is more than 2.5 times the amount he invested.
If Bob lives longer than 20 years, he will still receive a guaranteed income until he dies. The risk of his longevity, therefore, is carried by his insurer.
Should I choose a shorter or longer guaranteed term?
Your choice depends on your individual circumstances. You need to know the answers to the following questions:
- Have you saved enough for retirement? In other words, can you afford to leave an income to your beneficiaries, or do you need the highest possible income during retirement?
- Who is financially dependent on your income?
- Do you have an elderly parent who will need an income for the next 10 years if you pass away suddenly?
- You might have a disabled dependant in which case you could consider the highest guaranteed term possible that will provide an income for your dependant after your death. You could also consider a product that leaves a possible lump sum .
- If you have no dependants, you won’t need to leave an income and therefore, you could opt for the higher income.
- What is your medical history and current health status?
- If your life expectancy is shorter due to ill health, you could consider the following:
- a longer guaranteed term to provide income for dependants after your death; or
- a product that will pay an income to you during your lifetime as well as a predetermined lump sum to your dependants after your death; or
- a product such as a living annuity where you have the freedom to determine the level of your income but that could leave a lump sum for your dependants after your death if any underlying capital has been preserved.
- If you are healthy with a longer life expectancy, consider a shorter guaranteed term for the higher income in combination with other income-, growth- and -creating products.
- If your life expectancy is shorter due to ill health, you could consider the following:
- Your best solution could be a combination and not only one specific product.
One size doesn’t fit all
As we’ve illustrated, retirees’ varied income requirements set the scene for a well-rounded, diversified retirement income portfolio that could consist of multiple products.
In most cases, a single product or solution will not tick every box for you. So, combining retirement income products and features can ensure the best outcome for your retirement.
Your financial intermediary will blend a solution based on financial goals that are unique to your specific needs.
